The Arbitration Fairness Act of 2007: Are the Days of Mandatory Arbitration Provisions Numbered?

The AFA also would amend Section 2 of the FAA to invalidate all predispute arbitration agreements that require arbitration of:

1) An employment, consumer, or franchise dispute; or

2) A dispute arising under any statute intended to protect civil rights or to regulate contracts or transactions between parties of unequal bargaining power.

The proposed legislation not only stands to affect the rights of franchisors and franchises in disputes as between them, but also stands to affect franchisors and franchisees that may have mandatory arbitration provisions in their respective employment or consumer agreements. Moreover, the proposed amendments to the FAA appear to open a Pandora's box of applicability to a broad spectrum of contracting parties, as it will also apply to disputes arising under statutes intended 'to regulate contracts or transactions between parties of unequal bargaining power.' The AFA does not proffer an explicit definition for this latter type of dispute, but it does proffer definitions for what constitute consumer, employment, and franchise disputes.

The AFA defines consumer, employment, and franchise disputes as follows:

(3) 'employment dispute', as herein defined, means a dispute between an employer and employee arising out of the relationship of employer and employee as defined by the Fair Labor Standards Act;

(4) 'consumer dispute', as herein defined, means a dispute between a person other than an organization who seeks or acquires real or personal property, services, money, or credit for personal, family, or household purposes and the seller or provider of such property, services, money, or credit;

(5) 'franchise dispute', as herein defined, means a dispute between a franchisor and franchisee arising out of or relating to contract or agreement by which '

(A) a franchisee is granted the right to engage in the business of offering, selling, or distributing goods or services under a marketing plan or system prescribed in substantial part by a franchisor;

(B) the operation of the franchisee's business pursuant to such plan or system is substantially associated with the franchisor's trademark, service mark, trade name, logotype, advertising, or other commercial symbol designating the franchisor or its affiliate; and

(C) the franchisee is required to pay, directly or indirectly, a franchise fee; …

What is perhaps the most interesting, if not altogether disturbing, aspect of the AFA's proposed applicability to 'franchise disputes' is that absolutely nothing is said about franchising in its proposed Congressional 'Findings' or why such statutory amendments to the FAA are needed in the franchise dispute context. A review of the proposed 'Findings' clearly imparts the sense that it is 'consumers and employees' who are perceived to be in most specific need of protection, as it is they who have 'little or no meaningful option whether to submit their claims to arbitration … ' If it is, as the AFA says, that '[m]andatory arbitration is a poor system for protecting civil rights and consumer rights because it is not transparent' for lack of meaningful 'judicial review,' the proffered 'Findings' do not elucidate the reader as to how or why its applicability should include franchise disputes. This same focus on consumer and employee protection is echoed on Sen. Feingold's Web site (see http://feingold.senate.gov/issues_arbitration.html).

It is also noteworthy that the proposed 'Findings' expressly conclude that the FAA 'was intended to apply to disputes between commercial entities of generally similar sophistication and bargaining power' and that 'Private arbitration companies are sometimes under great pressure to devise systems that favor the corporate repeat players who decide whether those companies will receive their lucrative business.' Conspicuously omitted from these conclusory 'Findings' is the identification of any objective or, for that matter, any anecdotal evidence to support either such proposed finding.

Far-Reaching Impact Can Be Imagined

Although the AFA is not particularly complex in terms of the language it uses, nor is its purpose complicated to understand, its potential impact on the franchise community appears to be so broad and far reaching as to render the FAA wholly ineffective in all but a handful of contractual disputes that involve franchisors and/or their franchisees. The economic costs, both direct and indirect, to franchisors and their franchisees that the AFA stands to impose ' though not empirically calculated ' clearly include an increase in the expenses associated with handling a host of contractual disputes well beyond those related to the franchise relationship itself. At a time when the legal profession and our judges are fighting for better judicial salaries in an American judiciary that is clearly underfunded, it is hard to imagine that such broad amendments to the FAA can result to constitute a net economic gain for society. Though the AFA may represent an attempt at protecting certain disenfranchised or vulnerable segments of our society, it nonetheless does not appear to constitute the best or most effective mechanism to effectuate such a lofty purpose.

The FAA represents Congress' enactment of a statutory rule of contract construction favoring arbitration. Congress passed the FAA in the face of historical judicial hostility to arbitration.

The current interest in attacking mandatory arbitration seems to be coming from legislators who are concerned about abuses in the securities industry and the consolidation of security industries arbitration. Notwithstanding any such perceived industry-specific need, the AFA's provisions are sweeping in scope and raise the question of whether the AFA's proposed amendments, if adopted, would be the exception that effectively subsumes the current rule that is the FAA.

John J. Jacko III is a franchise, commercial, and business litigator and a member of the Government Contracts Section of the law firm of Buchanan Ingersoll & Rooney PC (http://www.buchananingersoll.com/) in its Philadelphia and Princeton, NJ, offices. He can be reached at [email protected] or 215-665-3923. This article is intended for general informational purposes only and does not constitute legal advice. Readers are advised to consult with an attorney in order to procure legal advice as to any specific circumstances or legal questions they want reviewed.

A 'consumer protection' bill that would bar as invalid and unenforceable mandatory arbitration provisions relating to, among other things, franchise disputes is presently referred to the Senate's Judiciary Committee and the House of Representatives' Committee on the Judiciary and its Subcommittee on Commerce and Administrative Law. If passed by Congress, the Arbitration Fairness Act of 2007 ('AFA') (S. 1782 and H.R. 3010) introduced by sponsors, Sen. Russ Feingold (D-WI) and U.S. Rep. Hank Johnson (D-GA), would significantly, in both the eyes of franchisors and their franchisees, amend the Federal Arbitration Act, 9 U.S.C. '1, et seq. ('FAA') to not only invalidate mandatory arbitration provisions in the context of franchise disputes, but also for consumer and employment disputes as well. (To see the text of the legislation or monitor its progress, see the Library of Congress' http://thomas.loc.gov/.)

In Wake of Ehleiter v. Grapetree Shores, Inc.

The introduction of the AFA on July 12, 2007 comes on the heels of the Third Circuit's recent decision in Ehleiter v. Grapetree Shores, Inc. , 482 F.3d 207 (3d Cir. 2007), which determined that the 'waiver of the right to arbitrate based on litigation conduct remains presumptively an issue for the court to decide … ' ( Ehleiter , 482 F.3d at 221) under the FAA. Proposed statutory language in the AFA provides that Section 2 of the FAA would be amended to expressly provide that the validity and enforceability of predispute arbitration provisions (i.e., 'any agreement to arbitrate disputes that had not yet arisen at the time of the making of the agreement') 'shall be determined by Federal law' and that 'the validity or enforceability of an agreement to arbitrate shall be determined by the court, rather than the arbitrator, irrespective of whether the party resisting arbitration challenges the arbitration agreement specifically or in conjunction with other terms of the contract containing such agreement.'

The AFA also would amend Section 2 of the FAA to invalidate all predispute arbitration agreements that require arbitration of:

1) An employment, consumer, or franchise dispute; or

2) A dispute arising under any statute intended to protect civil rights or to regulate contracts or transactions between parties of unequal bargaining power.

The proposed legislation not only stands to affect the rights of franchisors and franchises in disputes as between them, but also stands to affect franchisors and franchisees that may have mandatory arbitration provisions in their respective employment or consumer agreements. Moreover, the proposed amendments to the FAA appear to open a Pandora's box of applicability to a broad spectrum of contracting parties, as it will also apply to disputes arising under statutes intended 'to regulate contracts or transactions between parties of unequal bargaining power.' The AFA does not proffer an explicit definition for this latter type of dispute, but it does proffer definitions for what constitute consumer, employment, and franchise disputes.

The AFA defines consumer, employment, and franchise disputes as follows:

(3) 'employment dispute', as herein defined, means a dispute between an employer and employee arising out of the relationship of employer and employee as defined by the Fair Labor Standards Act;

(4) 'consumer dispute', as herein defined, means a dispute between a person other than an organization who seeks or acquires real or personal property, services, money, or credit for personal, family, or household purposes and the seller or provider of such property, services, money, or credit;

(5) 'franchise dispute', as herein defined, means a dispute between a franchisor and franchisee arising out of or relating to contract or agreement by which '

(A) a franchisee is granted the right to engage in the business of offering, selling, or distributing goods or services under a marketing plan or system prescribed in substantial part by a franchisor;

(B) the operation of the franchisee's business pursuant to such plan or system is substantially associated with the franchisor's trademark, service mark, trade name, logotype, advertising, or other commercial symbol designating the franchisor or its affiliate; and

(C) the franchisee is required to pay, directly or indirectly, a franchise fee; …

What is perhaps the most interesting, if not altogether disturbing, aspect of the AFA's proposed applicability to 'franchise disputes' is that absolutely nothing is said about franchising in its proposed Congressional 'Findings' or why such statutory amendments to the FAA are needed in the franchise dispute context. A review of the proposed 'Findings' clearly imparts the sense that it is 'consumers and employees' who are perceived to be in most specific need of protection, as it is they who have 'little or no meaningful option whether to submit their claims to arbitration … ' If it is, as the AFA says, that '[m]andatory arbitration is a poor system for protecting civil rights and consumer rights because it is not transparent' for lack of meaningful 'judicial review,' the proffered 'Findings' do not elucidate the reader as to how or why its applicability should include franchise disputes. This same focus on consumer and employee protection is echoed on Sen. Feingold's Web site (see http://feingold.senate.gov/issues_arbitration.html).

It is also noteworthy that the proposed 'Findings' expressly conclude that the FAA 'was intended to apply to disputes between commercial entities of generally similar sophistication and bargaining power' and that 'Private arbitration companies are sometimes under great pressure to devise systems that favor the corporate repeat players who decide whether those companies will receive their lucrative business.' Conspicuously omitted from these conclusory 'Findings' is the identification of any objective or, for that matter, any anecdotal evidence to support either such proposed finding.

Far-Reaching Impact Can Be Imagined

Although the AFA is not particularly complex in terms of the language it uses, nor is its purpose complicated to understand, its potential impact on the franchise community appears to be so broad and far reaching as to render the FAA wholly ineffective in all but a handful of contractual disputes that involve franchisors and/or their franchisees. The economic costs, both direct and indirect, to franchisors and their franchisees that the AFA stands to impose ' though not empirically calculated ' clearly include an increase in the expenses associated with handling a host of contractual disputes well beyond those related to the franchise relationship itself. At a time when the legal profession and our judges are fighting for better judicial salaries in an American judiciary that is clearly underfunded, it is hard to imagine that such broad amendments to the FAA can result to constitute a net economic gain for society. Though the AFA may represent an attempt at protecting certain disenfranchised or vulnerable segments of our society, it nonetheless does not appear to constitute the best or most effective mechanism to effectuate such a lofty purpose.

The FAA represents Congress' enactment of a statutory rule of contract construction favoring arbitration. Congress passed the FAA in the face of historical judicial hostility to arbitration.

The current interest in attacking mandatory arbitration seems to be coming from legislators who are concerned about abuses in the securities industry and the consolidation of security industries arbitration. Notwithstanding any such perceived industry-specific need, the AFA's provisions are sweeping in scope and raise the question of whether the AFA's proposed amendments, if adopted, would be the exception that effectively subsumes the current rule that is the FAA.

John J. Jacko III is a franchise, commercial, and business litigator and a member of the Government Contracts Section of the law firm of Buchanan Ingersoll & Rooney PC (http://www.buchananingersoll.com/) in its Philadelphia and Princeton, NJ, offices. He can be reached at [email protected] or 215-665-3923. This article is intended for general informational purposes only and does not constitute legal advice. Readers are advised to consult with an attorney in order to procure legal advice as to any specific circumstances or legal questions they want reviewed.